Potluck à la Wall Street: 'Idea dinners'

On a cold evening a few months back, 25 casually clad traders and portfolio managers gathered in a Bear Stearns conference room in New York over crab cakes and filet mignon to discuss stock ideas in the technology sector.

Bear Stearns technology and telecommunications analysts waxed poetic about their ideas and encouraged the usually cagey traders and managers to share theirs, without much success.

Few would acknowledge that they came away from the meeting with anything worthwhile. "Information is key," a trader who has attended various idea dinners said. "You don't want to give away what you've got."

But in smaller, more intimate settings, the same traders are inclined to talk about stocks they liked and stocks they are betting against - gossiping about who has what position and pondering how to make money in a challenging market.

Since ideas are the lifeblood of markets, it is perhaps not surprising that there are many versions of what Wall Street calls "idea dinners."

DeMatteo Monness, a boutique brokerage firm, holds not only regular dinners but a kind of high-end dating service for managers, helping like-minded hedge fund and mutual fund managers meet.

Managers also compete to be on prominent instant message lists. Being on the list of the hedge fund manager Steven Cohen, of SAC Capital, is the equivalent of hanging out with the coolest kid in the class. Some funds have shared morning calls, as Wall Street research houses do.

Shared ideas, though, mean shared impact. Markets depend on the free flow of ideas, but as hedge funds have ballooned in size they have moved from the fringes of Wall Street to being the engine fueling recent market manias. So when hedge funds stop thinking like ahead-of-the curve outsiders and become part of the herd, that is when the market can be whipsawed.

That is what appears to have happened recently when various hedge funds got caught in trades involving General Motors stock and bonds. As managers took a bath on their positions, it was clear that many had nearly identical trading strategies. Others, they realized, had the same ideas and had made similar bets.

Cooperation among hedge funds creates two kinds of fears: one, that the funds quietly cooperate to drive a stock price up or down and then jump out, leaving other, less in-the-know investors holding the bag. The second is that the compensation structure of hedge funds - they are expected to make money in both good and bad markets, and they are paid mostly on the basis of their returns - is pure incentive to bet the house.

When markets become turbulent and returns look weak, the less-regulated sector of hedge funds is naturally where regulators would expect to see problems.

This is not to say that hedge funds are crazed casinos. The Federal Reserve has frequently said that the funds mitigate risk by dispersing it.

At the same time, pension funds and endowments are playing a significantly larger role as investors in hedge funds. The expectations of investment returns among these institutional investors tend to be around 10 percent a year, tamping down demands for super-size returns that might call for risky, super-size investments.

And leverage, or borrowed money, is relatively low, meaning hedge funds and funds of funds are not - at least not yet - close to the levels that existed in 1998, when Long-Term Capital Management nearly collapsed.

Concerns about sharing ideas center on math and psychology: Hedge funds are playing a larger role in the market - they account for some 50 percent of the trading on the London and New York stock exchanges, according to one study. So with any market shock, such markets will be at the mercy of hedge funds and the unwinding of their trades.

Worries about a herd mentality are putting a premium on creativity and new sources of information. Managers and traders are hungry for different methods of research. The Gerson Lehrman Group, for instance, helps money managers find experts, enabling the managers to do primary research rather than rely on intermediaries. Kroll continues to build its business doing research - private investigations - for hedge funds.

Not all idea dinners focus on a particular strategy - which should ease regulators' concerns - but can take longer, much broader outlooks.

At an idea dinner in New York last week, the investor Stanley Druckenmiller saw gloom and doom for the markets. With a 50 percent chance of a deep recession in 2006 and a 75 percent chance of a major financial crisis in the next five years - a view that some attribute originally to Paul Volcker, the former Fed chairman - the market may not have to worry about good ideas.

Which is probably why the next speaker joked that Duquesne, the name of Druckenmiller's fund, was Latin for "scare the hell out of everyone."